The flight capital fallacy

Ignacio de la Torre. Professor. IE Business School

30 March 2016

Contrary to what the media says, capital is not fleeing Spain. Rather, thanks to the ECB’s monetary policy, Spanish firms are funding themselves using cheaper loans.

Imagine that right in the middle of the credit crunch of 2012, a Spanish company that needed credit got a 100 million euros from a foreign fund at 8%.  In 2015 the company notices that banks are offering very attractive credit conditions with an interest rate of 3%, partly because the bank can, in turn, get funds from the European Central Bank through the Bank of Spain (Eurosystem through Target II) at interest rates that are at record lows.  The company, logically, takes out a new loan at 3%, and repays the 100 million to the foreign fund, cutting funding costs by 5%. While we would all see this procedure as the sensible thing to do, from a statistical standpoint gullible observers may see this as “capital flight” to the tune of 100 million euros. 

But there is no capital flight taking place here.

This week prestigious Spanish newspapers ran with alarming headlines like “Last year levels of capital flight in Spain were at their highest since 2012.” The sub headings were just as spine-chilling (“Investors took 70.2 billion euros out of Spain in 2015, taking out 19 billion in December alone), and the graphs accompanying the article looked very daunting (a blue line going upward to represent capital flight, with another line going downward representing “entry,” according to which in 2015 there was a massive spike similar to the one that occurred in 2011 and 2012).

The news echoed Spain’s figures on current account and financial balances published by the Bank of Spain a few days earlier, a four-page long article in which the bank stated: “It is estimated that in the course of 2015 some 70 billion euros net left Spain.  The Bank of Spain’s net exterior debt went up by 11 billion in December of 2015 and by 40.6 billion over the course of 2015.”  Given that today we hardly differentiate information from analysis, this part of the news article spawned all kinds of salacious news which appeared to point to Spain’s return to the worst years of the crisis.

By analyzing the figures we can also see that: a) that investors invested 24.8 billion euros in Spain via direct foreign investment (purchase of Spanish firms, for example) in 2014, and a further 20.3 billion euros in 2015. Hence there is no capital flight and there is still investment going on; b) “portfolio” investors, or rather those who buy Spanish bonds and stocks and shares, invested 59.1 billion in 2014, and another 55.2 billion in 2015 and did not take flight either; c) there is a third section called “other investments” (which includes loans, repos and deposits), which accounts for the much feared “flight”, specifically the net flight of 48.8 billion euros; and d) the Bank of Spain’s debt position with regard to the Eurosystem increased (that is to say figured as an entry) by 50.9 billion.

So where does this this false idea of “flight” come from?  Banks and Spanish firms are taking full advantage of the highly advantageous conditions currently offered by the European Central Bank, channeling via Target II through the Eurosystem and the Bank of Spain.  Banks are cancelling deposits and repos with foreign banks, and replacing said funding with that supplied by the ECB, particularly at the end of the year, given that wholesale funding markets have got more expensive. Firms are cancelling loans taken out with foreign lenders at high rates of interest and replacing them with cheaper bank loans, thanks precisely to the calming effect of the ECB. The result is that Spain has received 50.9 million Euros more funding via the ECB at very attractive rates, and has used said funding to, among other things, cancel other far more burdensome investments. In other worlds, given that the “flight” is calculated by “excluding the Bank of Spain,” those entities that are financing themselves using cheaper interest rates supplied by the ECB are driving false statistics that account for five sevenths of the “flight”. And the rest? 

Spain generated a current account and capital surplus of some 22.7 billion euros over the course of 2015.  In other words, Spain saved more than it spent, and the excess savings are being channeled toward the rest of the world, enabling it to reduce its debt. This was achieved due, among other things, to the fact that during 2015 Spain achieved a record level of exports of goods and services, reaching 358 billion euros, while it imported goods and services to the value of 330.6 billion euros. This is something it can be very proud of, given that a nation that exports capital to the rest of the world runs fewer risks than one that lives off money borrowed from outside (like Spain was doing before the crisis). As a result of Spain’s surplus current account, when it exports capital to the rest of the world, the money “leaves.”  It is not capital flight, but rather the heroic consequence of being one of nations that has most increased its number of exports in recent years. This explains the remaining two sevenths of the “flight.”  

Conclusion, there is no flight of capital taking place. Spain is proceeding to fund itself in the best possible conditions as a result of the ECB’s monetary policy, and is also funding the rest of the world, which means that it is reducing its foreign debt little by little. Nevertheless, when capital “entered” and net foreign debt went up, the headlines were “Spain worsens its international debt position,” and now that it is exporting capital and reducing external debt, the headline reads “capital flight.” 

There is no capital flight. What there should be is a flight of the media’s pandering to populism. 

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